Ronson Inc; a technology company, is evaluating the possible acquisition of Blak

Question

Ronson Inc; a technology company, is evaluating the possible acquisition of Blake equipment company. If the acquisition is made, it will occur on January 1, 2009. All cash flows shown in the income statements are assumed to occur at the end of the year. Blake currently has a capital structure of 40% debt, but Ronson would increase that to 50% if the acquisition were made. Blake, if independent, would pay taxes at 20%, but its income would be taxed at 35% if it were consolidated. Blake’s current market-determined beta is 1.40, and its investment bankers think that its beta would rise to 1.50 if the debt ratio were increased to 50%. The cost of goods sold is expected to be 65% of sales, but it could vary somewhat. Depreciation-generated funds would be used to replace worn-out equipment, so they would not be available to Ronson’s shareholders. The risk-free rate is 8%, and the market risk premium is 4%. . a. What is the appropriate discount rate for valuing the acquisition? b. What is the terminal value? c. What is the value of Blake to Ronson? d. Suppose, Blake has 120,000 shares outstanding. What is the maximum per share price Ronson should offer for Blake?

I followed the example of a similar problem that was posted, but I wanted to verify that I did the calculations correctly.

Ronson Inc. 2009 2010 2011 2012 Net sales $450 $518 $555 $600 Selling and administrative expense 45 53 60 68 Interest 18 21 24 27 Tax rate after merger 35% Cost of goods sold as a % of sales 65% Beta after merger 1.5% Risk-free rate 8% Market risk premium 4% Terminal growth rate of cash flow 7% available to Ronson 2009 2010 2011 2012 Sales $450.00 $518.00 $555.00 $600.00 Cost of Goods Sold (65%) 292.5 336.7 Gross Profit 157.5 181.3 Selling/admin. Costs 45.0 53.0 EBIT 112.5 128.3 Interest 18.0 21.0 EBT 94.5 107.3 Taxes (35%) 33.1 37.6 Net Income/Cash Flow $61.4 $69.7 Rfr MRP New beta 8% 4% 1.50 14% The appropriate discount rate for valuing the acquisition is 14%. Terminal value calculation 2009 2010 2011 2012 Net sales $450.00 $518.00 $555.00 $600.00 Cost of goods sold $292.50 $336.70 $360.75 $390.00 Selling & Admin. Exp $45.00 $53.00 $60.00 $68.00 Interest $18.00 $21.00 $24.00 $27.00 PBT $94.50 $107.30 $110.25 $115.00 Tax at 35% $33.075 $37.555 $38.5875 $40.25 PAT/Cash flow $61.425 $69.745 $71.6625 $74.75 Terminal Value Calculation Cash flow for 2013 $79.9825 Terminal value per DCF=CF2013/(Re-g) $1,142.607 Value of Blake to Ronson 2009 2010 2011 2012 2012 $53.8815789 $53.66651 $48.3701463 $44.2580007 $676.515 Total Value $876.6914 Maximum price that Ronson should offer to Blake Maximum price=Value of Blake to Ronson/Total No. of shares $7.31 *Dollar amounts in thousands

Explanation / Answer

In the case of acquistion, that discount rate used should be that of the seller after incorporating the firm specific risks. So, the beta after the acquisition should be considered by the buyer.

So, your computation of discount rate, which is cost of equity, is correct

Also, the computation of cashflows available to the equity holders is correct.

The terminal value also has been computed correctly and then discounted to the present period.

Overall, the computation of value/share is correct.

Related Questions

Navigate

• Browse (All)
• Browse R
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.